Energy Prices Not Headed for a Collapse

By 2010, crude oil will average $100/barrel, same as this year.

By Jim Ostroff, Associate Editor, The Kiplinger Letter

December 8, 2008

Don’t get complacent about lower oil prices. This market slide has overshot the mark, just as the upward swing did earlier this year. As we said last spring, supply/demand fundamentals didn't support oil prices of $150 a barrel or more. Now they don’t warrant prices of $50 or less.

Eventually, the market will correct itself. But first, prices are likely to slip further. They’ll bob around $40 to $50 a barrel this winter, possibly even briefly dipping to nearer the $30 mark, making locking in purchases soon a smart move.

The recession is obscuring the hard facts. The supply cushion remains fairly thin in global terms. But the psychological pressure is now on the downward rather than the upward side. Prices will start to head up in spring 2009, climbing as signs of economic recovery emerge.

Drivers are taking to the road again with today’s low prices planting the seeds of future hikes. The move toward conservation and energy efficiency won’t evaporate. We believe it’s here to stay. But it’s a long-term trend that will move at a trot, not the gallop spurred by $4 gasoline. "We are in the midst of a new, long-term cycle in which consumers and businesses will focus on energy conservation, slowing the growth of oil and fuels consumption," says Timothy Evans, an energy analyst at Citigroup Global Markets.

In the near term, OPEC’s starting to worry, so much so that it really is cutting output, with less cheating on limits than usual. By midwinter, that will help slash the surplus in oil worldwide to about 1.3 million barrels a day, cutting the cushion in half.

By December 2009, we’ll see prices of $75 to $80 a barrel, yielding an average of $70 or so. At the gasoline pump, consumers will fork over about $2 a gallon. For diesel, they’ll pay an average of $2.90 over the course of the year. For heating oil…$2.60.

Come 2010, growing oil consumption will again push prices to $100 a barrel, an average that will match the sting of this year’s. What isn’t likely to be matched: The extreme volatility of 2008, when speculative buying, combined with a wafer-thin cushion of supply & demand, pushed prices to the stratosphere and economic recession let them fall rapidly earthward as the hot money fled.

"When the economy gets back on track in 2010 or so, demand for oil and fuels will ratchet back up and bump up against supply constraints, meaning we'll be right back in the soup," says John Kilduff, a senior vice president with MFGlobal, a commodities trading firm.

Global demand will climb to 88 million barrels a day, within a whisker of the maximum available in 2010. In contrast, demand today is about 84.5 million barrels. Shortages of diesel fuel refining capacity will reappear. Planned new refineries fell victim to the recession. That will push average diesel prices toward the $4 mark. As for gasoline prices, they’ll climb by a buck from 2009. And we expect heating oil to run about $3.75 a gallon.

"We are setting up for a replay of [near $5-a-gallon] diesel fuel prices this past summer because of all the new refinery projects that are being tabled indefinitely amidst the economic crisis," says Kilduff.

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